India After Independence: 1947-2000 (60 page)

In fact, the restrictions on multinational corporations and suspicion of foreign capital increased in this period. No advantage could be taken of the internationalization of production and of the increased international flow of funds. As for exports, though successful efforts were made to diversify them, both in terms of commodity composition (e.g., the rapid shift to manufactured exports, it being 2/3 of total exports in 1980-81 rising to 3/4 in 1989-90) and in terms of geographical spread, the
quantitative expansion or the increase in volume of exports lagged far behind the potential created by the world expansion of trade, which was successfully exploited by the East Asian countries. In fact, India’s share in world exports actually shrunk from about 2.4 per cent in 1948 to 0.42 per cent in 1980, rising to a still paltry 0.6 per cent by 1994. The volume of India’s manufactured exports in 1980-81 was half that of China, one-third of Brazil and a quarter of South Korea.

India was thus unable to use the opportunities provided by the changed world situation to rapidly industrialize and transform its economy, increase income levels and drastically reduce poverty levels, as did many of the East Asian countries. South Korea, for example, had a per capita income level comparable to India in the sixties (based on purchasing power parity) and today South Korean income levels are knocking at the doors of levels achieved by advanced countries, while India is still pretty much near the bottom of the heap. Even China changed track in 1978, opening up its economy, participating in the globalization process, welcoming foreign investment, pushing up its exports, and so on, leading to a current growth rate much higher than India’s. Between 1980-89, China!s real GDP, by one estimate, grew at an average rate of 9.4 per cent, considerably faster than did India’s over the same period. Though the figures for China are not fully reliable, yet economists agree that China was well ahead of India in this respect.

One may add here that India’s poor growth in exports had implications regarding the productivity levels achieved in the country. In fact, countries like Japan and South Korea have effectively used export obligation on the part of various enterprises as a mechanism of enforcing international competitiveness through maintenance of high productivity levels. Enterprises or business houses which failed to meet the export obligation because of lack of competitiveness were blacklisted and suffered serious consequences, sometimes leading to bankruptcy.

The third set of problems which overtook the Indian economy was primarily the result of certain political imperatives, and which was related to the manner in which the Indian state structure and democratic framework evolved. More and more sections emerged which made strong, articulate demands on state resources. Governments, however, were increasingly unable either to meet these demands fully or diffuse the clamour for them, This resulted in the gradual abandoning of fiscal prudence from about the mid-seventies. A situation was created where the macroeconomic balance, which was maintained in India (unlike, many other developing countries) with great caution for the first twenty-five years or so after independence, was being slowly eroded. The macroeconomic imbalance that now emerged tended to be long term and structural in character as distinct from the short-term imbalances created by shocks such as those of the mid-sixties or the seventies, related to oil.

The gradual erosion of fiscal prudence was reflected in government expenditure rising consistently, mainly because of the proliferation of subsidies and grants, salary increases with no relationship to efficiency or
output, overstaffing and other ‘populist’ measures such as massive loan waivers. Growing political instability and political competition, as the Congress party’s sole hegemony began to erode, led to competitive populism with each party trying to outdo the other in distributing largesse. Also, it has been argued that with the prestige of Congress waning, it was no longer able to stand above competing groups pressing for an immediate increase in their share of the national cake and rein them in with the promise of rapid growth and a just income distribution in the future if current demands were subdued. Further, with Mrs Gandhi increasingly centralising power in her hands, democratic functioning within the Congress party declined, with the party gradually losing its organizational links with and control over the grassroots. Political bargaining between sections of society was now not done within party structures but through budget allocations. Lastly, with parties clearly representing sectional interests, such as that of the rich and middle peasants, coming to power in several states after the 1967 elections and even beginning to have a say in the Centre since 1977, huge budgetary allocations were often made which were in the nature of sectional subsidies at the cost of an expenditure pattern best suited to overall development.

How did these political imperatives translate in real economic terms? As we saw earlier, the, response to the mid-sixties crisis was fiscal and balance of payments caution. However, a certain relaxation of fiscal discipline began after 1975 and particularly during the Janata regime of 1977-79. The food subsidies doubled between 1975-76 and 1976-77 from Rs. 2.5 billion to Rs. 5 billion. The fertilizer subsidy multiplied ten times from Rs. 0.6 billion in 1976-77 to Rs. 6.03 billion in 1979-80. The export subsidy multiplied by about four and a half times from Rs. 0.8 billion to Rs. 3.75 billion between 1974-75 to 1978-79. During 1977-79 (the Janata period) procurement prices for foodgrains were increased without corresponding increases in issue prices, taxes on a wide range of agricultural inputs were decreased and budgetary transfers to loss-making public sector units increased. In fact, the 1979 budget has been described by eminent economists Vijay Joshi and I.M.D. Little as a ‘watershed marking the change from previous fiscal conservatism.’
⁴

The fiscal profligacy continued through the eighties and particularly during the second half, reaching absurd limits where, for example, the V. P. Singh-led National Front govermnent that came to power in 1989 announced a loan waiver for the farmers which would cost the exchequer more than Rs. 100 billion. The direct subsidies from the central budget on only food, fertilizer and exports in 1980-81 have been estimated to exceed Rs. 15 billion, an amount equal to half of the total gross capital formation in manufacturing in the public sector that year! While there was this explosive growth of government spending, the savings generated by the government or public sector kept falling with their growing losses.

The result of fiscal profligacy was that the consolidated government (centre and states) fiscal deficits rose sharply from 4.1 per cent of GDP in 1974-75 to 6.5 per cent in 1979-80, 9.7 per cent in 1984-85, peaking
at 10.4 per cent in 1991. Governments in this period tended to seek ways and means of increasing their domestic and foreign borrowing to meet this deficit rather than either trying to increase govermnent savings or reduce government expenditure. In fact, the gap between public (government) investment and public savings widened threateningly. After the crisis of mid-sixties the gap had been brought down to 3.6 per cent of GDP between 1968-69 and 1971-72, but rose to 5.3 per cent in 1980-81 and 9 per cent by 1989-90.

The growing government saving-investment gap and the fiscal deficit had a negative impact on the balance of payments and debt situation. From a situation of balance of payments surplus on the current account in 1977-78 of $1.5 billion (1.4 per cent of GDP), by 1980-81 there was a deficit in the current account to the tune of $2.9 billion (1.7 per cent of GDP). The deficit increased to $3.5 billion (1.8 per cent of GDP) in 1984-85 and rose very sharply thereafter to $9.9 billion (3.5 per cent of GDP) in 1990-91. It must be noted that the rapid worsening of the balance of payments situation, especially in the late eighties, was neither due to any major external shock nor due to import liberalization. In fact, the second half of the eighties saw an actual improvement in trade balance with exports growing rapidly at an average of about 14 per cent per year in dollar terms. The overall economy’s saving-investment gap which had risen to an average of about 2.5 per cent of GDP between 1985-90 (as the huge public savings-investment gap could not be fully compensated by the substantial excess of household and private corporate saving over private investment) and the consequent necessity of heavy borrowing had caused the balance of payments deficit.

It must be noted that the eighties were a period of high growth. Between 1985-90, on an average, India’s GDP grew at over 5.5 per cent per year, industry at over 7 per cent, capital goods at 10 per cent, consumer durables at 12 per cent and so on. However, this growth was not a result of any step-up of savings and investment; in many ways it was a result of over-borrowing and over-spending. The growth was both debt led (like Latin America of the seventies) and the result of an explosion of domestic budgetary spending. This kind of growth was naturally not sustainable as the macrocconomic imbalances were bound to reach a point where a crash could no longer be postponed—as happened in Latin America in the eighties and in India almost a decade later.

The deteriorating fiscal and balance of payments situation had led to a mounting debt problem, both domestic and foreign, reaching crisis proportions by the end of the eighties. Total govermnent (Centre and state) domestic debt rose from 31.8 per cent of GDP in 1974-75 to 45.7 per cent in 1984-85 to 54.6 per cent in 1989-90. The foreign debt situation also became very precarious with debt rising from $23.5 billion in 1980-81 to $37.3 billion in 1985-86 to $83.8 billion 1990-91. The debt service ratio (i.e., payment of principal plus interest as a proportion of exports of goods and services) which was still a manageable 10.2 per cent in 1980-81 rose to a dangerous 35 per cent in 1990-91. Moreover, the proportion of
concessional debt to total debt also fell from over 80 per cent to about 40 per cent in this period, i.e., increasingly, the debt consisted of short-term commercial borrowing. The prejudice against foreign direct investment, which still remained, led to this excessive dependence on foreign debt rather than foreign equity capital, and inadequate returns on the borrowings led to an unsustainable debt service burden.

India’s foreign exchange reserves fell from $5.85 billion in 1980-81 to $4.1 billion in 1989-90, and in the next year they fell drastically by nearly half to $2.24 billion in 1990-91, enough only for one month’s import cover. The Iraqi invasion of Kuwait in August 1990, leading to an increase in oil prices and a fall in Indian exports to the Mddle East or Gulf region, partly contributed to this alarming foreign exchange situation. India’s international credit rating was sharply downgraded and it was becoming extremely difficult to raise credit abroad. In addition, NRI (non-resident Indian) deposits in foreign exchange began to be withdrawn rapidly. In such a situation, where foreign lending had virtually dried up, the government was forced to sell 20 tonnes of gold to the Union Bank of Switzerland in March 1991 to tide over its immediate transactions. By July 1991 foreign exchange reserves were down to a mere two weeks import cover despite loans from the IMF. The country was at the edge of default.

This is the situation (June 1991) in which the minority Congress government of Narasimha Rao took over power and with Manmohan Singh as finance minister attempted one of the most important economic reforms since independence.

The long-term constraints that were building up over a few decades and debilitating the Indian economy combined with certain more recent and immediate factors led to a massive fiscal and balance of payments crisis that climaxed in 1991. (See
chapter 26
.) The crisis pushed India into initiating a process of economic reform and structural adjustment. The reforms, which in the Indian context were almost revolutionary in nature, were ironically started by a minority government led by Narasimha Rao, and guided by one of the most distinguished economists of post-independence India, Manmohan Singh, as finance minister.

Reform of the dirigiste, controls-ridden and inward-looking Indian economy was long overdue. As early as the early sixties, Manmohan Singh had argued (quite bravely, given the intellectual climate of the period) that India’s export pessimism at that time was unjustified. He advised more openness and a less controlled economy.
¹
Other eminent Indian economists such as Jagdish Bhagwati were among those who urged reform in the early stages. An attempt at reform was made in the mid-sixties but it got stymied for a variety of reasons discussed elsewhere (see section 1, chapter 26), leading to a further recoiling into restrictionist policies. The seventies witnessed some, what has been described as, ‘reform by stealth’, with the rupee being allowed to depreciate in response to market conditions not by an outright devaluation, which was then politically unviable, but by pegging it to a depreciating sterling. Indira Gandhi, particularly after her return to power in 1980, tried to bring in liberalization measures, mainly in the area of deregulation of industrial licensing and reduction of restrictions on large ‘monopoly’ enterprises. Though by the standards of the post-1991 reforms these efforts would appear puny, a glance at the newspapers of the eighties would suggest that they were seen as quite path-breaking (particularly by the critics) at that time. Rajiv Gandhi, when he took over in 1984, attempted reform at a relatively quicker pace towards industrial deregulation, exchange rate flexibility and partial lifting of import controls. The major issue of the emerging macroeconomic imbalance, calling for stabilization of the fiscal and balance of payments deficits, was however left unattended, despite the
expressed intentions to the contrary. Reforms of the financial and labour markets and the public sector also essentially remained untouched. Even these piecemeal attempts at reforms made by Rajiv Gandhi got abandoned after some time mainly due to the political crisis centred around the Bofors allegations and the desertion of V. P. Singh and others.

Though the need for reform had been recognized early enough, its comprehensive implementation could not occur for various reasons. Governments, especially when in a vulnerable situation (e.g., Rajiv Gandhi after the Bofors scandal, Indira Gandhi with the Punjab crisis, and later even Narasimha Rao following the destruction of the Babri Masjid), were extremely wary of initiating or sustaining reforms which would involve introducing unpopular measures like attempts to regain fiscal discipline, change in labour laws, steps which in the initial phase were bound to be painful. Also, there was (and still remains) persistent opposition to reform from vested interests such as the bureaucracy and even sections of business who benefited from the existing system of controls, using them to earn a sort of ‘rent’. Last, and certainly not the least, a strong ideological opposition from the orthodox left, strangely oblivious to the changing global reality, continued to play a role in obstructing reform.

The crisis in 1991, with the country at the edge of default, enabled the Narasimha Rao government to break through the traditional mindset and attempt an unprecedented, comprehensive change at a time when both the ideological opposition and the resistance of the vested interests was at a weak point. Thus, though late, nearly thirteen years after China changed course, a programme of economic reform was initiated in 1991. One reason why the shift took so long and, even when it took place, was not as sharp a turnaround as it was in China in 1978 or the Soviet Union after the mid-eighties was that in a democracy the change from one kind of societal consensus (such as the Nehruvian consensus) to a new consensus (say around reforms) had to be a process and not an event, and which had its own dynamic, very different from that operating in a non-democratic or totalitarian society.

The process of reforms started in 1991, involved, inter alia, an immediate fiscal correction; making the exchange rate more realistically linked to the market the (rupee underwent about a 20 per cent devaluation at the very outset); liberalization of trade and industrial controls like freer access to imports; a considerable dismantling of the industrial licensing system and the abolition of MRTP; reform of the public sector including gradual privatization; reform of the capital markets and the financial sector; removing a large number of the restrictions on multinational corporations and foreign investment and welcoming them, particularly foreign direct investment, and so on. In short, it was an attempt to free the economy from stifling internal controls as well as equip it to participate in the worldwide globalization process to its advantage.

The record of the first few years of reform was creditable by any standards, though a lot of problems and challenges still remained. India
performed one of the fastest recoveries from a deep macroeconomic crisis. Moreover, the process of structural adjustment, particularly the fiscal reining-in (done initially), was achieved with relatively minimal pain—without it setting off a prolonged recessionary cycle leading to massive unemployment and deterioration of the condition of the poor as was feared and as occurred in the case of several other economies in a similar situation attempting structural adjustment.

For example, the growth rate of India’s Gross Domestic Product (GDP) which had fallen to a paltry 0.8 per cent in the crisis year of 1991-92 recovered quickly to 5.3 per cent by 1992-93 and rose further to 6.2 per cent in 1993-94 despite the major disturbances in 1992-93 triggered off by the Ayodhya crisis. More important, over the next three years, the Indian economy averaged an unprecedented growth rate of over 7.5 per cent, a rate closer to the high performers of East Asia than it had ever been before. Despite the crisis and the necessary structural adjustment, the Eighth Plan (1992-1997) averaged a growth rate of nearly 7 per cent (6.94), higher, and on a more sustainable basis, than the Seventh Plan (1985-1990) average of 6 per cent. Gross Domestic Savings averaged over 23 per cent between 1991 and 1997, higher than the Seventh Plan average of 20.6 per cent. Gross Domestic Capital Formation (Investment) and Gross Domestic Fixed Capital Formation between 1992 to 1997 also maintained a respectable average of 25.2 per cent and 22.3 per cent of GDP respectively, considerably higher than the Seventh Plan average of 21.8 and 19.8 per cent.

Industrial production, which showed a dismal, less than one per cent, growth rate in 1991-92 (it was negative in manufacturing), picked up to 2.3 per cent in 1992-93 and 6 per cent in 1993-94, peaking at an unprecedented 12.8 per cent during 1995-96. The capital goods sector, which demonstrated negative growth rates for a few years, bounced back to nearly 25 per cent growth in 1994-95, allaying early fears that import liberalization would hit the domestic capital goods industry adversely. The small-scale sector too grew faster than overall industrial growth, suggesting that abolition of MRTP did not have an adverse effect on it and perhaps encouraged its growth. Agriculture, too, after recording a fall in 1991-92, picked up the following year and by and large maintained till 1996-7 the high rate of growth of over 3 per cent which it had been experiencing for some years.

The central government’s fiscal deficit, which had reached 8.3 per cent of GDP in 1990-91, was reduced and averaged roughly 6 per cent between 1992-97. The important thing was that out of the total fiscal deficit of 5.2 per cent in 1996-97, 4.7 per cent was accounted for by interest payments which was a liability emanating from part fiscal laxity. The primary deficit, i.e., fiscal deficit net of interest payments, which represents current fiscal pressures or overspending was only 0.6 per cent in 1996-97, was systematically brought down from 4.3 per cent of GDP in 1990-91 and 2.9 per cent in 1993-94.

The external sector also showed considerable improvement. Exports,
which registered a decline of 1.5 per cent in dollar terms during 1991-92, recovered quickly and maintained an average growth rate of nearly 20 per cent between 1993-96. Very significantly, India’s self-reliance was increasing to the extent that a considerably larger proportion of imports were now paid for by exports, with the ratio of export earnings to import payments rising from an average of 60 per cent in the eighties to nearly 90 per cent by the mid-nineties. The current account deficit in balance of payments, which had reached an unsustainable 3.2 per cent of GDP in 1990-91, was brought down to 0.4 per cent in 1993-94 and rose since then to 1.6 per cent in 1995-96. Yet the average deficit between 1991-92 and 1997-98 was about 1.1 per cent, significantly lower than the Seventh Plan (1985-90) average of about 2.3 per cent. The foreign exchange reserves (including gold and SDRS) had grown to a respectable $30.4 billion at the end of January 1999, providing cover for about seven months of imports as compared to a mere two weeks in July 1991.

The debt situation had also started moving away from a crisis point. The overall external debt/GDP ratio for India fell from a peak of 41 per cent in 1991-92 to 28.7 per cent in 1995-96. The debt service ratio also fell from the peak of 35.3 per cent in 1990-91 to 19.5 per cent in 1997-98. It is, however, still quite high compared to China, Malaysia and South Korea, who all had (till 1997) debt service ratios below 10 per cent.

Reforms and liberalization of the stock market since the eighties and particularly after 1991 produced dramatic results. The total market capitalization on the Indian stock markets as a proportion of GDP rose from a mere 5 per cent in 1980 to 13 per cent in 1990 and, following further reforms since 1991, it rose rapidly to 60 per cent of GDP by the end of 1993. By 1995, the Indian stock market was the largest in the world in terms of the number of listed companies—larger even than the US. Measures such as the repeal of the Capital Issues Control Act of 1947 (through which the government used to control new issues and their prices) and the external liberalisation (which inter alia allowed foreign institutional investors to buy Indian corporate shares and enabled Indian companies to raise funds from foreign markets) considerably increased the Indian companies’ ability to raise funds from the stock market (including in foreign exchange) to finance their development and growth. The amount of capital Indian companies could raise in the primary market in India increased from Rs 929 million in 1980 to Rs 2.5 billion in 1985 and Rs 123 billion in 1990. By 1993-4 the figure had reached Rs 225 billion—a nearly 250 times increase since 1980.
²
A substantial 12.8 per cent of the country’s gross domestic savings was accounted for by new corporate securities in 1993-4, up from about 1 per cent in 1981. Also, permission to access the international market enabled Indian companies, during 1994-95, to raise $2.03 billion through 29 Euro issues of Global Depository Receipts (GDRS) and Foreign Currency Convertible Bonds (FCCBs). Upto December 1995, Indian firms had raised $5.18 billion through 64 issues of GDRs and FCCB.

The encouragement to foreign investment bore fruit with foreign
direct investment (FDI) increasing at nearly 100 per cent per year between 1991 to 1996, it being $129 million in 1991-92 and $2.1 billion in 1995-96. Total foreign investment including portfolio investment increased from $102 million in 1990-91 to $4.9 billion in 1995-96. Considerable improvement, no doubt, but yet a far cry from what was being achieved by the East Asian countries. China alone had been absorbing more than $30 billion of foreign direct investment every year for some years, the figure for 1996 being $40.8 billion. One positive sign, however, was that one of the most stubborn mindsets—the xenophobia about foreign capital—seems to have been eroded, with the Common Minimum Programme (CMP) of the coalition government (following the defeat of the Congress in 1996), to which even the Communists were a party, desiring that the foreign direct investment (FDI) in India should rise to $10 billion per year. However, the danger emanating from the relatively volatile nature of foreign portfolio investments, with the possibility of their sudden withdrawal (as happened in Mexico and more recently in South-east Asia) due to often unpredictable extraneous factors, was understood by successive governments and efforts made to control short-term capital inflows and capital flight.

Critics of reform, mainly from the orthodox left, made the charge that reform was anti-poor, a major (and perhaps the only somewhat credible) plank of their arguments. However, studies of a large number of countries have shown that barring a few exceptions, rapid economic growth has been associated with fall in poverty levels. India too witnessed significant fall in poverty levels with the relatively faster economic growth of the eighties. The proportion of population below the poverty line (the poverty ratio) fell from 51.3 per cent in 1977-78 to 38.9 per cent in 1987-88. Countries like China and Indonesia, which had much higher poverty ratios of 59.5 and 64.3 in 1975 compared to India’s 54.9 in 1973-4, were able to reduce their poverty levels to much below India’s in the span of twenty years. These countries maintained a much higher rate of growth than India during this period and their poverty ratios had fallen dramatically to 22.2 and 11.4 respectively by 1995, while India’s had fallen only to 36 by 1993-94.
³

To the extent, therefore, that the economic reforms were designed to put India on a higher growth path, it would be expected that poverty levels would decline as well. The key question remaining was what would be the impact on poverty in the transitional phase, especially when the necessary stabilization had to take place with the attempts to improve the balance of payments position and reduce the fiscal deficit, leading to a possible fall in govermnent expenditure. India’s initial stabilization programme was said to be ‘extraordinarily successful’ causing ‘remarkably little suffering’ when ‘compared with most other countries which were forced to effect a large and rapid reduction in their current external account deficits.’
⁴
Calculations based on several different indicators of poverty show that poverty, mainly rural poverty, marked a significant rise only in 1992-93 and its causation was linked mainly to a drought and fall in foodgrain
output in 1991-92, leading to a rise in food prices, and very weakly to the stabilization programme. Even this was perhaps avoidable to a great extent. The government’s failure in not anticipating the situation and maintaining expenditure on rural employment programmes, its not refraining from making any cuts (in real terms, there being a nominal increase) in the anti-poverty Social Services and Rural Development (SSRD) expenditure in 1991-92 to achieve fiscal stabilization, has been criticised even by the supporters of reform. However, all the poverty indicators showed that by 1993-94 there was much improvement in the poverty situation. The poverty levels, both rural and urban, were significantly lower in 1993-94 than in 1992, by nearly six percentage points, and were lower than the pre-reform average of the five years 1986-87 to 1990-91.
⁵
Thus, it may be noted that the stabilization under the reforms had little negative impact, if any, on poverty levels. Other aspects of structural reform, it is generally agreed, do not threaten the poor and in fact would improve their condition by releasing the full growth potential of the economy.